15 March 2018
Will Airbus and Boeing raise their single-aisle jetliner production rates to 70 per month? The industry has heard growing talk of these increases, which could come just a few years after the end of the decade. The current state of demand justifies these rates. But the current state of demand is based on an almost perfect confluence of market conditions. Here’s why that might not last.
Right now, the industry is still focused on getting to its current production objectives. This has proven difficult, with numerous stumbles related to the new generation engines powering the latest models. Airbus plans to get to 60 A320neo series jets per month in mid 2019, while Boeing is aiming for 57 737MAXs per month around the same time. The scramble to build planes is based on unprecedented demand. Boeing currently has 4,615 outstanding orders for its 737 family, while Airbus holds a 6,126 jet backlog for its A320 series.
Still, suppliers have reservations about the sustainability of the new rumored production rates, which is understandable given the heavy investments the industry would need to get there. This is particularly true for the engine primes, CFM International (General Electric/Safran) and United Technologies' Pratt & Whitney.
Historically, the jetliner market has seen a depressing pattern of cyclicality: about seven good years are routinely followed by about three bad years. Something has changed, and the industry hasn’t seen a downturn since 2003. But suppliers are still understandably wary about a possible return of an historical pattern that lasted for half a century.
If executed, the rumored rate rises would produce remarkable numbers. Total annual output of 1,680 narrowbodies per year would be about four times 2004’s 425 A320/737 deliveries, the low point of the last jetliner market bust.
Assuming the new rates were achieved in 2023, the single aisle segment would have seen 450% growth (by value of deliveries) over 19 years, in constant year dollars. More single-aisle jets will have been delivered between 2010 and 2024 than were delivered in the first 51 years of the jet age, 1958-2009. The impact of the new rates is seen in our chart, based on current manufacturer guidance through 2019 and assuming a gradual rise to 70 per month for both families.
But looking at history, it becomes clear that we’re living in an unusual moment. Things are almost impossibly perfect right now, both in aviation and the broader macroeconomic environment. The aviation industry is starting to plan for a five year (or longer) future based on some remarkably happy times, which may continue. Or not.
First, there’s the outside world. The U.S. economy has now been expanding for nine straight years, with no signs of a slowdown. The IMF and OECD are both forecasting global growth of 3.9% this year, up from 3.7% in 2017. All the major regions of the world are enjoying this growth, and China, the biggest single market for jetliners, is still growing at around 6.5%.
Two other key exogenous factors impacting jet demand are the price of fuel and the cost of capital. Fuel is in the Goldilocks zone, $62/bbl for West Texas Intermediate. If fuel goes down, to $40 or below, airlines will be far less likely to re-equip with new, more efficient jets, and more likely to keep older equipment longer. If fuel goes up, to $75 or above, they’ll have a harder time making money, and as they raise fares to compensate travel demand will likely fall. But $62 really is the sweet spot.
Meanwhile, cash is still very cheap. The Federal Funds Effective Rate just is 1.5%, up from an extended period of around 0%. This is forecasted to get to 2.1% this year, but considering that as recently as 2007 it was 5%, interest rates are still reasonably low.
The ratio between the cost of money and the cost of fuel plays a big role in airline thinking. A combination of 0% interest and $100 fuel effectively means that an airline should absolutely finance new jet purchases to replace older, less efficient jets. Today’s ratio is still pretty good. But 5% interest rates and $40 fuel would mean a lot of airlines simply hang on to older equipment.
Then, there’s the aviation business itself, which is in remarkable shape. Airline travel demand, as measured in revenue passenger kilometers, grew at a very strong 7.6% pace last year, well above the 5.5% average rate of the last ten years. Best of all, in key growth markets like China, travel demand is staying high even as GDP growth rates decline. Also, airline profits have stayed remarkably strong over the past three years, a sharp contrast to the many years of thin profits, or horrible losses, of previous decades.
Finally, despite a global wave of populism and a move towards tariffs and against free trade, there are still no obstacles to the global sale of new and used jets. The threat of trade wars would make jets the easiest target. For example, if China decided to favor orders from either supplier, as a form of retaliation against the U.S. or Europe, that would remove around 25% of single aisle demand from the other manufacturer.
The key takeaway is clear. Airbus and Boeing might be able to get to 70 per month narrowbody rates in the next decade. If, that is, history comes to a halt, and economic and aviation market conditions for the next five years stay just as great as they are today.